A decisive cut to South African interest rates by the South African Reserve Bank has sparked a rally in the value of the South African Rand, as investors saw the move as ultimately being supportive of an economy that is under severe pressure owing to a strict coronavirus lockdown.

The South African Reserve Bank (SARB) cut the repo rate by 50 basis points, taking it to 3.75% per annum, with effect from 22 May 2020.

According to the Minutes of the May Monetary Policy Committee meeting, three members preferred a cut of 50 basis points and two preferred a cut of 25 basis points.

Lesetja Kganyago, Governor of the South African Reserve Bank, said the decision to cut South Africa's basic interest rate resulted from the sharp economic contraction facing the country.

The SARB will have felt they had leeway to cut by a deeper 50 basis points as they expect inflation to be "well contained over the medium-term", remaining close to the midpoint in 2021 and 2022. "The overall risks to the inflation outlook at this time appear to be to the downside, but less clearly so compared to conditions in March and April," said Kganyago.

The SARB’s headline consumer price inflation forecast averages 3.4% for 2020 and 4.4% in 2021 and 2022. The forecast for core inflation is lower at 3.5% in 2020, 3.8% in 2021, and 4.1% in 2022.

"With inflation expected to continue to slow in coming months, further cuts might be on the cards at the June MPC meeting as well as later in the year," says Paul Muller, Executive Director at Peregrine Treasury Solutions.

The reaction by the Rand exchange rate complex suggests the cut was deeper than markets had been expected: The Pound-to-Rand exchange rate fell 1.52% to reach 21.60, the U.S. Dollar-to-Rand exchange rate fell by a similar amount to 17.64 while the Euro-to-Rand exchange rate fell 1.60% to reach 19.36.

"The rand swiftly rose to R17.53/$ before dropping back to R17.65 after the announcement, after trading stronger in earlier trade today," says Muller. "Risk appetite towards emerging markets will continue to be the main driver of further rand movements in the weeks to come, with resistance to stronger levels being tested."

Above: GBP/ZAR price action in the wake of the SARB decision

The SARB currently expects GDP in 2020 to contract by 7.0%, compared to the 6.1% contraction forecast in April.

"Even as the lockdown is relaxed in coming months, for the year as a whole, investment, exports and imports are expected to decline sharply. Job losses are also expected to be widespread," said Kganyago.

However, "getting back to pre-pandemic activity levels will take time," added Kganyago.

GDP is expected to grow by 3.8% in 2021 and by 2.9% in 2022.

The SARB has already cut its policy rate aggressively in recent months to deal with the impact of COVID-19, it had already cut 225bps since the start of the year ahead of the May decision.

On March 20 the SARB also announced liquidity measures which included allowing banks access to cheaper funding, increasing the number of repo auctions, and reducing the upper and lower limits of the standing facility borrowing rate, in addition to a secondary market bond-buying programme.

The SARB has also announced temporary relief on bank capital requirements and a reduction of the liquidity coverage ratio from 100% to 80%.

The Rand extended its advance on the Dollar and Pound Tuesday as investors eyed the greener grass on the other side of the coronavirus pasture and analysts say the South African currency can hold onto its recently recovered turf.

A decisive cut to South African interest rates by the South African Reserve Bank has sparked a rally in the value of the South African Rand, as investors saw the move as ultimately being supportive of an economy that is under severe pressure owing to a strict coronavirus lockdown.

The Rand charged higher against the Dollar and Pound Wednesday as financial market volatility ebbed and investors remained in an upbeat mood but forecasts from ABN Amro and Commerzbank suggest the South African unit may already be nearing the end of its proverbial road, with upside limited from here.

The Rand was wavering and at risk of falling to a new low against the Dollar Friday as tensions between the U.S. and China were ratcheted higher by brinksmanship between Washington and Beijing, which placed parts of the emerging market currency complex under pressure.

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